9 Stocks Undervalued to Target Price With Strong Sources of Profitability

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 |  Includes: ACIIQ, CMEDQ, GLDD, GM, HAL, MBT, PWER, TSL, VALE
by: Kapitall

After looking at price multiples and other relative measures of value to determine that a stock appears undervalued, one way to further verify this is by looking at the health of company’s profitability. Healthy operations should translate into a higher valuation that matches comparisons of fair value.

To that end, we ran a DuPont analysis on a universe of stocks that are deeply discounted from their mean analyst target price (used as a proxy for fair value). Although target price is known to be upwardly biased, a deep discount from target price can indicate undervaluation.



From this DuPont analysis, we found 9 companies that passed all requirements for positive results. We broke the ROE equation into three parts:

ROE
= (Net Profit/Equity)
= (Net profit/Sales)*(Sales/Assets)*(Assets/Equity)
= (Net Profit margin)*(Asset turnover)*(Leverage ratio)

All of the stocks mentioned below have seen rising ROE values for the recent quarter, year-over-year. Then we wanted to analyze the sources of these returns, so we narrowed down the original universe to only focus on companies with the following characteristics:

• Decreasing leverage, i.e. decreasing Asset/Equity ratio
• Improving asset use efficiency (i.e. declining Sales/Assets ratio) and improving net profit margin (i.e. declining Net Income/Sales ratio)

Companies passing all requirements are thus experiencing increasing profits due to operations and not to increased use of leverage.

Do you think these stocks are undervalued? Use this list as a starting point for your own analysis.

List sorted by discount from target price.

1. Vale S.A. (NYSE:VALE): Steel & Iron Industry. Market cap of $164.27B. Target price at $41.68 vs. current price at $30.54 (implies a discount of 26.73%). Return on Equity increased from 2.75% to 8.86%. When analyzing the sources of return, Net Profit Margin increased from 24.29% to 51.66%. Sales/Assets increased from 0.0633 to 0.0985, while Assets/Equity decreased from 1.7920 to 1.7426 (comparing 3 months ending 3/31/10 vs. 3 months ending 3/31/11). The stock has gained 11.75% over the last year.

2. General Motors Company (NYSE:GM): Auto Manufacturers Industry. Market cap of $49.34B. Target price at $42.97 vs. current price at $31.56 (implies a discount of 26.55%). Return on Equity increased from 3.65% to 8.81%. When analyzing the sources of return, Net Profit Margin increased from 3.39% to 9.30%. Sales/Assets increased from 0.2314 to 0.2482, while Assets/Equity decreased from 4.6524 to 3.8182 (comparing 3 months ending 3/31/10 vs. 3 months ending 3/31/11).



3. Arch Coal Inc. (ACI): Industrial Metals & Minerals Industry. Market cap of $5.18B. Target price at $41.39 vs. current price at $30.58 (implies a discount of 26.12%). Return on Equity increased from -0.09% to 2.43%. When analyzing the sources of return, Net Profit Margin increased from -0.25% to 6.37%. Sales/Assets increased from 0.1479 to 0.1782, while Assets/Equity decreased from 2.2864 to 2.1382 (comparing 3 months ending 3/31/10 vs. 3 months ending 3/31/11). The stock has gained 30.88% over the last year.



4. Trina Solar Ltd. (NYSE:TSL): Semiconductor Industry. Market cap of $2.13B. Target price at $35.56 vs. current price at $26.59 (implies a discount of 25.22%). Return on Equity increased from 7.19% to 12.38%. When analyzing the sources of return, Net Profit Margin increased from 15.58% to 22.64%. Sales/Assets increased from 0.2023 to 0.3010, while Assets/Equity decreased from 2.2798 to 1.8166 (comparing 3 months ending 12/31/09 vs. 3 months ending 12/31/10). This is a risky stock that is significantly more volatile than the overall market (beta = 3.04). The stock has gained 26.5% over the last year.

5. Great Lakes Dredge & Dock Corporation (NASDAQ:GLDD): Heavy Construction Industry. Market cap of $387.23M. Target price at $8.75 vs. current price at $6.57 (implies a discount of 24.91%). Return on Equity increased from 0.42% to 2.43%. When analyzing the sources of return, Net Profit Margin increased from 0.64% to 3.95%. Sales/Assets increased from 0.2413 to 0.2480, while Assets/Equity decreased from 2.7073 to 2.4873 (comparing 3 months ending 12/31/09 vs. 3 months ending 12/31/10). The stock is a short squeeze candidate, with a short float at 5.06% (equivalent to 5.76 days of average volume).

6. Power-One Inc. (NASDAQ:PWER):
Diversified Electronics Industry. Market cap of $942.83M. Target price at $11.50 vs. current price at $8.72 (implies a discount of 24.17%). Return on Equity increased from 4.44% to 18.03%. When analyzing the sources of return, Net Profit Margin increased from 4.40% to 14.85%. Sales/Assets increased from 0.3836 to 0.4807, while Assets/Equity decreased from 2.6313 to 2.5256 (comparing 3 months ending 1/3/10 vs. 3 months ending 1/2/11). This is a risky stock that is significantly more volatile than the overall market (beta = 2.16). The stock is a short squeeze candidate, with a short float at 33.37% (equivalent to 7.35 days of average volume).

7. Mobile Telesystems OJSC (NYSE:MBT):
Wireless Communications Industry. Market cap of $20.08B. Target price at $27.09 vs. current price at $20.69 (implies a discount of 23.62%). Return on Equity increased from -0.68% to 5.00%. When analyzing the sources of return, Net Profit Margin increased from -0.84% to 5.22%. Sales/Assets increased from 0.1728 to 0.2069, while Assets/Equity decreased from 4.7133 to 4.6332 (comparing 3 months ending 12/31/09 vs. 3 months ending 12/31/10).

8. Halliburton Company (NYSE:HAL): Oil & Gas Equipment & Services Industry. Market cap of $44.28B. Target price at $61.19 vs. current price at $47.04 (implies a discount of 23.12%). Return on Equity increased from 2.31% to 4.68%. When analyzing the sources of return, Net Profit Margin increased from 5.48% to 9.67%. Sales/Assets increased from 0.2215 to 0.2781, while Assets/Equity decreased from 1.9012 to 1.7384 (comparing 3 months ending 3/31/10 vs. 3 months ending 3/31/11). The stock has gained 72.64% over the last year.

9. China Medical Technologies Inc. (CMED):
Medical Instruments & Supplies Industry. Market cap of $376.91M. Target price at $14.79 vs. current price at $11.67 (implies a discount of 21.10%). Return on Equity increased from -1.41% to 2.02%. When analyzing the sources of return, Net Profit Margin increased from -14.36% to 15.98%. Sales/Assets increased from 0.0348 to 0.0452, while Assets/Equity decreased from 2.8127 to 2.7988 (comparing 3 months ending 12/31/09 vs. 3 months ending 12/31/10).

*DuPont data sourced from Google Finance, target price and all other data sourced from Finviz.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.